Will Shanghai successfully realize free exchange of RMB?

As an international financial center, Shanghai is a pioneerof China's financial reform and opening-up. With more businesses coming into the city, the call for a further advancement in the free exchange of the renminbi (RMB) is rising amid the 30th anniversaryof the opening-up of Pudong.

China's currencyRMB is convertible for trade purposes under the current account,but it is not freely convertibleunderthe capital account, which covers portfolio investment and borrowing.

The country has introduced programs including the Qualified Foreign Institutional Investors (QFII), Qualified Domestic Institutional Investor (QDII), and Renminbi Qualified Foreign Institutional Investors (RQFII)to allow for more convenient capital inflowsand outflows.

Some say the RMB's status and exportsand importsvolume are not proportionate, and doing businesses would have additional costs because of the non-convertibility of theRMB. The financial hub Shanghai, especially, should do more in this respect.

'Itneeds a process'

Officialsand expertssay it takes timeand preparationfor the country to achieve the full convertibilityof the RMB.

Zhou Xiaochuan, former governor of the People's Bank of China(PBOC), and presidentof China Society for Finance and Banking, said the further internationalizationof the RMB should weigh the pros and cons to increasethe free useof the RMB, andminimizecapital account controls to the greatest extent, which involves research, way of thinking, policy system changes and emergency preparedness.

Further convertibility undercapital account does not mean 100percent liberalization,given that all countries have anti-money laundering and anti-terrorism requirements, and many financial transactions and forms of remittance are subject to restrictions, said Zhou at the 2020 Financial Street Forum in October.

The ultimate goal of the internationalization of the renminbi (RMB) is to achieve convertibility, but it needs a process. China has held on to the reform principle of "testingeach step before taking it" to achieve success through trials instead ofturning backafter failure, Qu Qiang, assistant director of the International Monetary Institute at Renmin University of China,told CGTN.

"We can't follow the old path that many developing countries have taken but failed. We can't let go at once without restraint and management, especially when our market system and financial supervision system are not mature, which is irresponsible for China itself as well as the international capitalmarket," Qu said.

The night skyline from the Bund in Shanghai, east China, November 5, 2019. /Xinhua

Favorable conditions

PBOC governor Yi Gang said at the Lujiazui Forumin June that Shanghai should take the lead in the unrestricteduse and the free exchange of the RMB, in a bid to realize the goal of building the city into a demonstration center of high-quality business environment.

Shanghai is becoming a risk management center for RMB assets. Investors who invest in RMB assets will carry out continuous risk diversification and management. The various elements of risk management in Shanghai are gradually improving, Yi said.

As long as the regulatory requirements onanti-money laundering, anti-terrorist financing, and anti-tax evasionare met, the funds required for normal trade and investment canfreely flow in and outof the city, Yiadded.

Qu said Shanghai can be a template in this regard. "Shanghai is a city that sees relativelya high international usage of the RMB in terms of finance, trade as well as foreign exchange, and global financial institutions that have a close connection with China all have branches in the city. It would be easier for the rest of the country to practice thetrail after learning from the experience of Shanghai."

Jimmy Zhu,chief strategist at Fullerton Research, said the current situation is conducive to promoting the internationalization of the RMB as China has done a good job in regards to pandemiccontrol.

The free exchange of the RMB was hindered by Fed rate hikes and the China-U.S. trade tension in recent years. But currently, it is favorable for China to push for the internationalization of the RMB as it has achievedgood results in the pandemic control and prevention, Zhu said.

Capital market pricing is paying more attentionto the factors related to the pandemic, so RMB assets areseeing high demand from foreign investors, compared with other assets. The internationalization of the RMB is expected to see major progress in the next two to three years, Zhu said.

More efforts needed

Experts say challenges remain in terms of the level of openness, the scope and the depth, and the replication of experience is also not easy.

Shanghai is a major city to conduct a pilot reform on the free exchange of the RMB, but if it can be replicated throughoutthe country remains a question.

"The factor of people should be considered. Weshould consider whether there are professionals to establishthe relatedlaws and regulations on foreign exchange and RMB circulation, or to implement relevant operational details,which requires a process. Whether other regions can do it well is still a question," Qu said.

In addition, we shouldalso notice that the central governmentlaunched preferential taxation and international trade policies for Shanghaiin a particular way. It should be considered whether these policies can be applied to other places, which would requirea new top-level design, Qu said.

The two-side convertibilityis also a goal to be achieved in the future.

Currently, China is paying more attention to the "bring in" of the foreign capital, so the "going out" of the RMB should also be strengthened to achieve two-side convertibility, Zhu said.

We can see efforts made in realizingthe convertibility ofthe RMB underthecapital account, to bring in more foreign capital. So, the next step, the "going out" of China's capital should be launched as soon as possible to achieve an equivalence, Qu said.

In addition, continued efforts should be made to diversify assets. There are quota restrictionson QFIIand QDII, and the assets that can be invested are relatively limited, which are mainly bellwether stockand blue chips, compared with those in other developed markets, Zhu said.

More areas are expected to be opened. For example, the country said in its 14th Five Year Plan that investmentin technology and innovation are encouraged. Also the improvement in high-end manufacturing will benefit the RMB internationalization process, Zhu said.

Also the monetary policy could be more transparent.

"Actually, the situation is much better than decades ago, especially the prediction of the central parity rates of the RMB against other major currencies," Zhu added.